- We take the view investors are now looking beyond yield investments, gravitating to reform driven markets, particularly “Indianesia” (India & Indonesia) equities. Amid a politically difficult backdrop, both India and Indonesia have passed key legislation that aims to lift government revenues during a time when major developed marked countries are expanding pubic debt.
- This matters for Emerging Asian markets, given India and Indonesia’s economies account for about 20% of Asia’s GDP and are the two major economies with current account deficits. Thus, a lower deficit would directly stabilize Asian foreign exchange rates, which helps mitigate flow if the Federal Reserve prepares to normalize rates at the end of this year.
- As investors assign market premiums where currency stabilization supports yield strategies, the paucity of positive real rates in developed markets makes Emerging Asia an attractive investment class, particularly if two of its largest economies continue to push forward with their tax agendas.
There are few guarantees beyond death and taxes. Though inevitable, western economies are attempting to escape both for as long as possible. Coupled with aging population profiles, developed markets are looking to reignite growth by shifting polices from fiscal austerity towards fiscal expansion. Across the globe, revised tax policies in Asia’s largest emerging economies are moving in the opposite direction, reflecting a positive change in an economic landscape where fiscal overhauls appear stunted.
This effort bodes positively for Asian markets, particularly “Indianesia” (India & Indonesia) equities, in our view. The ongoing agenda to obviate public debt abets economic dynamics and further attracts foreign investors into the region. Recent outperformance in Emerging Asian markets against developed bourses following the Brexit vote was to an extent driven by the yield trade as real positive rates attracted overseas capital. We take the view that investors are looking beyond yield investments, gravitating to reform-driven markets where pro-economic policies reduce vulnerabilities and uncertainties that negative interest rates and elevated debt levels beget.
During its August session, the Indian Parliament passed its long awaited Goods and Service Tax (GST) bill which aims to eliminate a cascading tax collection that hinders trade between states. While the near term impact is limited, with an estimated 0.8 to 1.0 percentage points added to medium term economic growth, the productivity gains are significantly larger. The cascading tax collection, where tax is essentially added on top of taxed items, incentivized Indian businesses to utilize loopholes and sacrifice efficiencies. The GST bill removes this economic drag of goods moving between states and now mirrors a similar uniformed customs practice recognized among European Union members.
Indonesia’s tax amnesty program, implemented in July, aims to not only serve as a vehicle to fund government infrastructure projects, but to also expand its collection base. Under the tax amnesty scheme, which ranges from 2 to 10 percent depending on type and timing of declaration, the government expects Rp1,000trn ($85bn USD, 9% of GDP) to be repatriated from overseas, adding Rp165trn ($12bn USD, 1% of GDP) to national revenues.
Both policies are strong on paper, but need political will to succeed. Century old complicated laws and license regulations have historically plagued India, while questions arise federal and state governments can jointly administer GST. Indonesia too faces a cultural distrust for tax authorities, where complicated tax codes have allowed collectors to seek extra revenue from those already legally paying. The Indianesian market would do best to instill compliance and reassurance that these taxes are clear and productive.
We believe that the policy support is evident, given that neither has been passed in isolation. Previous to GST, India also approved a new bankruptcy code in May and opened the market to greater foreign investments in July. In 2014, Joko Widodo removed contentious and politically sensitive fuel subsidies that had historically exacerbated the public budget. Both were achieved amid a divided congressional backdrop, as we believe that the leaders recognize the economic upside.
The Indianesian economies account for about 20% of Asia’s GDP and are the only two countries in Emerging Asia with current account deficits, 1.1% and 4.7% for India and Indonesia respectively. These tax reforms directly remove pressure on the current account deficits, which would need a weaker currency to achieve trading gains. For Indianesia, stabilization in the Indian rupee and Indonesian rupiah would also alleviate imported inflation on account of any fiat depreciation. Given the size of Indianesia to Asia, an improvement in fiscal accounts would directly stabilize Asia’s exchanges rates. With the US Federal Reserve striving to normalize borrowing costs at the end of 2016, smaller deficits could mitigate the outflow and preserve asset values.
While Indianesia’s demographic profile supports a favorable macroeconomic environment, infrastructure projects will continue to drive investment growth. Tax reforms would likely benefit Indian non-alcoholic and non-tobacco based consumer staples, which could see lower logistic costs and gains in operating efficiencies. Indonesian real estate is also a direct beneficiary of the tax amnesty program, as repatriated money can be invested in nonfinancial sectors such as property. As investors assign market premiums where currency stabilization supports yield strategies, the paucity of positive real rates in developed markets makes Emerging Asia an attractive investment class, particularly if two of its largest economies continue to push forward their tax agendas.
Assistant Fund Manager - Asia